If the Yuan Breaks This Key Level, We Could See a Wave of Redemptions

A flush of FX outflows threatens a breach of the 7 level vs. the dollar, and commodities will likely follow suit.

Yesterday afternoon, Bloomberg reported that the U.S. is preparing to announce tariffs on all remaining Chinese imports by early December, if next month's talks between presidents Donald Trump and Xi Jinping fail to ease the Trade War. Towards 2 p.m. ET, we saw a massive sell program in the U.S. that slammed stocks down into the close, with the S&P 500 touching 2600. This was the second biggest sell climax since May 2010's Flash-Crash.

The Dow and the S&P fell back into the red for the year, with the Nasdaq only up 1.4% year to date. All major equity indices are now in correction mode, below their critical levels and key 200-day moving averages. From their highs, the Dow is down 10.1%, S&P down 11%, Nasdaq down 14%, and the Russell 2000 down 15.5%.

As previously announced, the U.S. has already imposed tariffs on about $250 billion of goods imported from China. After the 10% increase on $200 billion worth of goods took effect in September, which are set to increase to 25% on January 1, Trump is now threatening to tax the remainder of Chinese goods imported -- which total about $505 billion as of last year. It has yet to be confirmed whether Trump and Xi Jinping will discuss trade tariffs when they meet at the G-20 Summit on November 29. Clearly, there is no sign of either side backing down.

Despite a stronger yuan fix, the offshore yuan tumbled down to 6.973 vs. the dollar, its lowest level since December 2016. Despite various attempts by the National Team to reassure the markets by stepping in to support them, the market continues to trade down. There is some serious concern out there whether the central bank has lost control altogether, as the Shanghai Composite is on track for one of the worst months since the Global Financial Crisis and its worst year since 2011.

A flush of FX outflows threatens the breach of the key 7 level -- and if it snaps, we can expect a flurry of total chaos and redemptions across the board. If it does break, commodities like copper will be break the key $6100/tonne level it is holding onto for dear life. That is a tremendous performance, despite turmoil in equity markets.

The charts are looking vulnerable, physical markets are strong -- but how long will they be able to hold the fort until some good news emerges. Looking at early indicators on business conditions and market sentiment, it does not bode well for China's October PMI data to be released later this week. There are signs of further slowdown and weakness in October data that we have yet to see. Could this force Chinese policymakers to engage in meaningful talks with Trump?

To be able to digest the 10%-20% move off the highs, one requires a gut made of steel. As disastrous as it may seem, most of these indices and stocks are still well off the lows seen in November 2016, when the rally first started after the Trump election. A case in point is Amazon (AMZN) which is down 25% from its highs, but is still up 200% since November 201. The S&P 500 is down 10% from its highs -- but is still up 26% from that time. Doom and gloom abound, the key question right now facing investors is whether the selloff is done.

The Wall Street Journal reported that hedge fund Frontline Capital was shutting down. This should come as no surprise, judging by how October performance has been -- and how long hedge funds were coming into the month, perhaps more casualties will arise. The sharp selloff will cause them to reduce their gross books and take risk down. Once exposure is flattened, and markets stabilize, then we can argue for some sort of bottom in place.

There are only two things that can provide clarity to investors and provide a basis of support -- the Fed announcing that they are pulling back on further rate hikes (taking a more accommodative stance) and/or the U.S. and China reaching to some sort of an agreement on Trade Wars. Until either of these happens, unfortunately there is no floor in sight as liquidations overtake fundamentals.

Investors question what level the S&P 500 needs to fall before the Fed steps in to provide support. In defence of the Fed, they have seen robust U.S. economic data, with contained inflation, as evidenced by the recent third-quarter GDP data. They are just doing their job, as the market still looks like it is in a "corrective" bull market mode. The probability of a December rate hike has fallen in recent days to less than 70% probability, but is still on the table.

For now, investors are screaming "paging Central Bank, paging Central Bank" like belligerent two year olds who are used to getting their way. For now, it remains to be seen whether they will.

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